Examination of Witnesses (Questions 220-239)
POSTCOMM
24 FEBRUARY 2009
Q220 Mr Wright: You suggest quite
clearly that it is self-financed. Royal Mail Group wanted to be
self-financed but you suggest that it is already there as far
as concerns the USO.
Mr Brown: The Royal Mail Letters
business and therefore all the products use the infrastructure
and we take the view that we should look at the profits of all
of them.
Q221 Mr Wright: So, you do not consider
there is a case to answer that there should be financial support
for the universal service obligation?
Mr Brown: We do not believe that
that is necessary at this moment. We believe that the modernisation
programme Royal Mail is undertaking and the improvement in its
efficiency should fund the profitability of Royal Mail Letters.
Mr Stapleton: My colleague has
already indicated—Mr Hoyle picked up the point—that
Royal Mail carried 99.5% of mail over the final mile. There are
three postal operators in Europe that have already lost over 10%
of their mail volumes over the final mile to competitors: Holland,
Germany and Sweden. All of those countries have self-sustaining
universal service with no government support whatsoever, the reason
being that those are mail businesses that are modernised and are
highly efficient. The only threat to a self-financing universal
service is lack of modernisation and the pension deficit, because
none of those three services has a pension deficit of the magnitude
that Royal Mail faces. Those are the differences. You do not need
to take our views. What has happened already in terms of the introduction
of mail competition elsewhere shows that you can have substantial
end-to-end competition and a self-financing universal service,
but you must have modernisation and you cannot carry the enormous
burden of a pension deficit.
Q222 Mr Wright: I think the modernisation
programme and pension deficit are huge problems, but as a lay
person in terms of the universal service obligation I cannot accept
that there is not a loss in providing that facility at the price
of 27p for a second-class stamp to send a letter across the country.
There must be an element of loss. I cannot figure out how you
can come to the conclusion that it is self-financing.
Mr Stapleton: The reason why there
is not a loss is that the volumes handled by Royal Mail are enormous
and the economies of scale more than make up for the inefficiencies.
If you do a rural round, as I try to do pretty frequently, there
is probably one stamped item in a postal delivery of five or six
items to each house. It is the fact that the universal service
is carried by the economies of scale and the 89% of Royal Mail's
revenue comes from business mail. Our major concern is about the
mail that is moving over to digital alternatives, for example
banks sending electronic statements and asking you to use the
internet. If that goes and Royal Mail does not modernise the only
alternative will be either a reduced specification of the universal
service or government subsidies like those being given to the
Post Office network. I do not think that either of those is an
option acceptable to government.
Q223 Mr Wright: If one takes the
view that it is making a loss then it is far better to accept
that and for some negotiations between yourselves and Royal Mail
Group, for instance, to come to that conclusion. You cannot have
a situation where you say post-Postcomm that it is self-financing
and then Royal Mail Groups says that it is £3.4 billion.
There is a huge disparity there. I just think that in terms of
the universal service obligation there is a form of subsidy in
existence.
Mr Stapleton: There is total agreement
that the Royal Mail Letters business last year made a profit of
£3 million. As my colleague said, that was net of the loss
on the universal service and the profit on the non-universal service,
but there were some big items that we as regulator took out of
the USO such as special delivery for businesses which transferred
a profit of £40 million from one side to the other. You should
look at the total picture. But our concern is that mail volumes
are falling at an accelerated rate. Usually mail volumes lag GNP
at least two quarters, so we have not yet seen the effects of
recession. The volume is going down by 3% this year. On Royal
Mail's figures it will go down by 7% next year. Price increases
are not making up for that volume decline and yet costs are still
going up by about 4%. Unless the cost line is attacked, what looks
today like a profit for the total mail business will be a big
loss in the years ahead.
Q224 Mr Oaten: How quickly do you
think the loss will arise?
Mr Stapleton: If Royal Mail is
talking about a 7% volume decline for next year, which is obviously
a reflection of the general state of the economy and the move
to digital, clearly it faces an enormous challenge in terms of
changing the direction in which its costs are moving if it is
to avoid moving into loss next year, even before one takes into
account the distinct possibility that if the pension deficit is
not removed the £280 million that is now being contributed
towards funding it may be two to three times as big next year.
Q225 Roger Berry: Obviously, we did
not need Hooper to tell us there was an issue about modernisation
and the pensions deficit. This Committee has talked about it for
years and years as have management and the trade unions. The distinct
point about Hooper is the proposal for a strategic partner, minority
shareholder or partial privatisation, call it what you will. The
reasons that have been given in support of that proposition boil
down to two or three basic ones. The first is about the need for
external expertise and new management and leadership. Why is it
that external leadership, management and expertise is necessary?
Why has not the existing management been able to do the job properly?
Mr Stapleton: The only point I
make is that that is one of three reasons Hooper came up with
and I do not see it as necessarily the strongest.
Roger Berry: I was planning to take them
one at a time.
Q226 Chairman: You would not necessarily
see it as the strongest reason?
Mr Stapleton: Of the three.
Q227 Roger Berry: How strong is it?
You have been the regulator. Is this a criticism of existing management?
Are they not up to the job? Do we need to get people from outside?
Mr Brown: Management operate within
the constraints they have been given. I think that the other reasons
in terms of introducing access to third parties and such like
enable it to get out of those constraints. If operates under a
big constraint in terms of the pension deficit. When you look
at many of the incumbents in other countries those pension problems
have been removed and therefore they are not subject to it. There
has also been greater separation between the company and government.
Q228 Roger Berry: Management operates
within constraints as we all do. I suspect that removal of the
pension deficit will command almost universal support. For reasons
we can go into—we do not have time—the government
should pick up the pensions deficit, but in my view what is proposed
by Hooper is the need for external expertise, management and leadership.
Presumably, it means that Hooper and his colleagues believe that
the present leadership is not up to the job. Why is it one of
the three?
Mr Brown: What Hooper has asked
for is expertise among those who have made a transformation and
have done this sort of thing before. It is getting access to that
knowledge and expertise to work with Royal Mail to make those
changes.
Q229 Roger Berry: But you believed
that people should be brought in to run Royal Mail. They were
not people who had had expertise in the past in transforming and
improving businesses. I seem to recall that that was the reason
for changes at the top which I warmly welcomed.
Mr Brown: I do not speak for Richard
Hooper but he makes fairly clear recommendations in terms of getting
access to the expertise and knowledge of those who have done this
in a network business. It is that specific expertise and access
to knowledge and understanding for which Hooper calls.
Q230 Chairman: But you are allowed
to disagree with Hooper; you do not have to endorse everything
he says. It may be a package but you can disagree with bits and
pieces of it. The question in my mind is: do we need someone with
transformational expertise, a network company or a postal operator
to be that strategic partner? Those are three different concepts.
Mr Brown: Our submission to Hooper
was that we thought the primary point was access to network expertise
and skills and experience of it.
Q231 Roger Berry: You do not believe
that that can be brought in without a shareholding?
Mr Stapleton: Strategic shareholding
brings a package of things.
Q232 Roger Berry: I want to turn
to capital later, but on management you are saying basically that
it is impossible to get new blood into the organisation, about
which you apparently feel quite strongly, without private shareholding.
You cannot buy in the expertise and employ consultants. I would
have thought it was quite common practice in the private/public
sector these days to buy in expertise that does not exist in the
organisation. Are you saying that that cannot be done in this
case?
Mr Stapleton: I do not think that
you will draw us on the point about separating out management
expertise from the division of political versus commercial considerations
and access to funding. Those three come together.
Roger Berry: I have not mentioned politics
yet, but let us turn to capital.
Q233 Mr Oaten: If I may intervene
quickly, are you saying that a cultural change is needed which
cannot be achieved by consultants coming in? You need a total
change in the culture of the management?
Mr Stapleton: Correct. It is still
a business which in terms of its culture goes back to the days
of the 1990s; it is a very difficult culture to change. We are
not critical of what the management team has achieved given the
constraints under which it has been working.
Q234 Roger Berry: I think the culture
today is different from when I first became a member of the Committee.
I recognise that the leadership of the organisation 10 years ago
was radically different and not as good as it is now, but the
question is whether or not the existing management is up to the
job. Clearly, you do not want to be tempted too much on that.
As to the question of bringing in a private shareholder for additional
finance, all the major private companies that I know these days
are running in the opposite direction; they are going to government
to ask for money to keep them afloat. Do you believe that getting
money from a private sector organisation is cheaper now and a
better deal than for government to fund it if it believes that
investment is necessary?
Mr Stapleton: Mr Berry, you are
aware that the £1.2 billion financing package that the government
gave to Royal Mail back in 2007 is still being challenged by the
European Union in the context of state aid grants. The money that
comes from the government has strings attached and clearly private
sector financing is of greater flexibility in that sense.
Q235 Roger Berry: Are you saying
that private companies would invest in Royal Mail without any
strings attached? They have no agenda and will just give it some
money and provide new management to do the job?
Mr Stapleton: Clearly, they will
want to see the rewards of a successful modernisation and share
with the government in the receipt of those rewards. Ofcom as
regulator will make sure that with or without a strategic shareholder
Royal Mail lives up to its obligations in terms of providing the
universal service. I read an awful lot which says that Royal Mail
needs to be 100% public owned in order to secure the universal
service. It is regulation that will make sure that the universal
service and competition are secured.
Q236 Roger Berry: With no disrespect,
I did not ask that question. How much do you think the Royal Mail
Group needs to modernise? If the responsibility for the pension
deficit transfers to the government—there is a powerful
argument for that—that releases £284 million a year.
There is already £600 million in the pipeline. How much more
is necessary?
Mr Stapleton: Royal Mail's own
figures indicate that it is 40% less efficient than best in class.
Hooper has a table which shows margins and comparators. In a business
that is 70% labour costs you can work out, with costs of £6
billion, quite how big that number is.
Q237 Roger Berry: These comparators
of efficiency are quite difficult, are they not? The cost of different
businesses providing these services in Europe might depend, for
example, on the amount of tax they pay. That will in turn influence
their profitability. There is a whole range of difficulties in
comparing one country with another. You are saying as regulator
that you cannot give me any figure about how much more than £284
million a year and the £600 million in the pipeline is necessary
to modernise which is what this is all about?
Mr Brown: Earlier my colleague
talked about Royal Mail's forecast of volume reductions of about
6% or 7% going forward. A 7% reduction in volume could without
action take £300 million straight off the bottom line of
Royal Mail, so while a solution to the pension deficit will give
a short-term boost to Royal Mail's profitability and cash flow
in the long term with a decline at that level due to e-substitution
and the recession Royal Mail's finances in the medium to long
term are challenged. That does not save it in the longer term.
As to how much money it needs to invest, the £1.2 billion
loaned two or three years ago is part of a modernisation programme
and plan that Royal Mail already has underway and is implementing,
but going forward the changes in investment it will need to make—I
know you will hear from Royal Mail after us—are larger than
that and they have to continue. It is not a question of doing
it and it is finished with; there must be continual investment.
Roger Berry: Mr Stapleton, you mentioned
quite rightly the issue of European legislation, state aids, competition
et cetera. Would not a strategic partner taking a shareholding
in Royal Mail be anti-competitive?
Q238 Chairman: Particularly if that
partner were to be TNT which is its major competitor?
Mr Stapleton: Clearly, that would
be an issue for the regulator. If what I read in the papers is
correct there are other parties with no presence in the UK at
the present time like the Finnish, Swedish and Danish postal operators
that are interested in the opportunity of a strategic shareholding.
You are absolutely right that TNT is one of the two large access
competitors in the UK and that would provide a competition issue
that clearly would have to be addressed if they became a shareholder.
Q239 Roger Berry: Despite all the
qualifications you have made about management, the cost of finance
and the issue about competition you have no doubt that it is absolutely
necessary for a private shareholding in Royal Mail?
Mr Stapleton: It is absolutely
necessary to make significant changes to the direction in which
the business has been moving over the past two to three years.
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